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McKinsey on semiconductors


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McKinsey on semiconductors

  1. 1. Number 1, Autumn 2011 McKinseyon Semiconductors McKinseyonSemiconductorsNumber1,Autumn2011 Will analog be as good tomorrow as it was yesterday? Getting Mo(o)re out of semiconductor R&D LED at the crossroads: Scenic route or expressway? Mastering variability in complex environments 50 57 64 71 From source to drain: Fixing the supply chain 42 Getting customers to say, ‘The price is right!’ 15 Creating value in the semiconductor industry 5 The challenge of China The evolution of business models in a disrupted value chain 22 33
  2. 2. McKinsey on Semiconductors is written by experts and practitioners in McKinsey & Company’s Semiconductors practice. To send comments or request copies, e-mail us: McKinsey_on_Semiconductors@ Editorial Board: Harald Bauer, Claus Benkert, Sri Kaza, Ulrich Naeher, Olivia Nottebohm, Nick Santhanam, Florian Weig, Bill Wiseman Editor: Brendan Hasenstab Editorial Production: Elizabeth Brown, Richard Bucci, Heather Byer, Nadia Davis, Torea Frey, John C. Sanchez, Venetia Simcock, Sneha Vats Art Direction and Design: Cary Shoda Illustrations by Celia Johnson McKinsey & Company Industry Publications Editor-in-Chief: Saul Rosenberg Managing Editor: Lucia Rahilly Copyright © 2011 McKinsey & Company. All rights reserved. This publication is not intended to be used as the basis for any transaction. Nothing herein shall be construed as legal, financial, accounting, investment, or other type of professional advice. If any such advice is required, the services of appropriate advisers should be sought. No part of this publication may be copied or redistributed in any form without the prior written permission of McKinsey & Company.
  3. 3. 1 5 Creating value in the semiconductor industry In light of increasing consolidation throughout the semiconductor value chain, companies that wish to succeed must move quickly to close capability gaps. 2 Introduction 57 Getting Mo(o)re out of semiconductor R&D Excellence in the R&D function is only one piece of a world-class product- development strategy. Via a new diagnostic and jointly developed plan, we can significantly reduce time to market for new chips while also improving overall quality. 42 From source to drain: Fixing the supply chain Supply-chain excellence has proved elusive for semiconductor players, but a handful of initiatives can yield significant improvement. 15 Getting customers to say, ‘The price is right!’ In a world where too many companies still believe that ‘if we build it they will come,’ practitioners of semiconductor sales know otherwise. This article lays out the elements essential to extracting the most value for current products by effectively communicating the true value of those products to customers. 33 The evolution of business models in a disrupted value chain The progress predicted by Moore’s Law has slowed in recent years. Players across the semiconductor value chain must adjust their approaches to compete as the industry continues to evolve. 71 Mastering variability in complex environments Variability adds cost to semiconductor production systems, but the ability to cope with it can also be a critical source of profit. A new approach goes beyond traditional tools to help companies control variability in their processes and make intelligent trade-offs in order to maximize return. 22 The challenge of China As barriers to Chinese competition weaken, local and foreign semi- conductor players must consider issues such as intellectual property and knowledge transfer to fully capture opportunities in this important market. 64 LED at the crossroads: Scenic route or expressway? Although adoption of LED lighting has been slow, roadblocks can be overcome with a compre- hensive approach that includes operational improvements, better marketing of products, and other efforts. 50 Will analog be as good tomorrow as it was yesterday? Many worry that 300mm manufacturing capacity will destabilize pricing across the analog semicon- ductor market. We argue that only a few seg- ments have reason to be concerned. McKinsey on Semiconductors Number 1, Autumn 2011
  4. 4. 2 Introduction Given the enormous and endlessly expanding role played by technology in the world economy, the layperson might be forgiven for assuming these are easy times for semiconductor companies. As our inaugural edition of McKinsey on Semiconductors notes, things are rather more complicated. On the one hand, the semiconductor industry is certainly enormous: it has grown to almost $300 billion, driven by a cycle of continuous improvements in technology, growth in demand, and innovation in end-use applications. On the other hand, as the authors of “Creating value in the semiconductor industry” note, while the semiconductor industry contributes dispropor- tionately to growth in US labor productivity and delivers tremendous value to consumers, most chip makers capture only a small percentage of the value they help create. In fact, excluding Intel, which made handsome profits indeed, the industry destroyed approximately $47 billion in value from 1996 to 2009. If semiconductor players are to meet market pressure to grow, they must lead convincingly on technology in their segment or grow in subsegments where they can differentiate themselves. China is a critical source of growth for nearly all established semiconductor players. Luckily for them, China has not yet developed a strong André Andonian, Harald Bauer, Sri Kaza, Ulrich Naeher, and Nick Santhanam
  5. 5. 3 indigenous semiconductor business, despite 20 years of effort. However, the forces that have held China back are weakening, and the government has launched a slate of initiatives aimed at developing strengths in three important new semiconductor markets: cloud computing, the “Internet of Things,” and electric vehicles. The result, as the authors of “The challenge of China” show, is that China will fight to hold on to its own market and may even compete for the developed-world market, too. Many of the industry’s challenges relate to keeping up with rapacious demand for new and better products. So it is ironic that “LED at the crossroads: Scenic route or expressway?” concerns an undoubted technological advance that is making extraordinarily slow progress into general use. The authors discuss five barriers to adoption that, if addressed, could lead to an LED-dominated lighting marketplace by 2015. Indeed, one might say the whole industry is at a crossroads: breakthrough innovations are needed to advance to the next node. Costs for manu- facturing equipment are rising exponentially. Few can afford to compete on the technology frontier created by Moore’s Law. And growth is concentrating only in select segments such as smart phones and mobile computing. Of course, the challenges differ by subsegment. “The evolution of business models in a disrupted value chain” proposes models for success in the fabless segment, explores the limits of vertical disintegration, and discusses how miniaturization is bringing success to outsourced semiconductor assembly and test (OSAT) players. One piece of the industry has been free from Moore’s Law’s punishing investment implications: the analog segment has historically been stable and profitable. In “Will analog be as good tomorrow as it was yesterday?” the authors examine the implications of the industry’s first 300mm-based manufacturing capacity. They ask whether this stability and profitability will endure. Despite many unsettling strategic issues, all semiconductor companies must still find ways to improve bottom-line results in the near term. The supply chain offers one important opportunity. Obviously, an industry that combines high capital intensity with long cycle times and a position far down the value chain will suffer supply- chain difficulties. But some are avoidable. As the authors of “From source to drain: Fixing the supply chain” note, supply-chain performance varies significantly, even within the same
  6. 6. 4 McKinsey on Semiconductors Autumn 2011 applications. The authors analyze excellent supply chains and discuss what it takes to create one. Pricing represents another opportunity. The semiconductor industry, in which price declines are as certain as death and taxes, is particularly prone to discounting to maintain market share. The authors of “Getting customers to say, ‘The price is right!’” explain how companies can school their sales forces to get customers to see products through the lens of their value, rather than their cost. Only through value selling, they suggest, can the discounting cycle be broken. Next, we take on research and development. How can companies overcome a long history of time and budget overruns in the face of ever- changing customer expectations? The authors of “Getting Mo(o)re out of semiconductor R&D” explain that getting R&D right implicates many functions, including marketing, sales, pro- duction, and even supply chain, and so urge a broader view of the product-development process, in which all involved functions are engaged. By examining one or two end- to-end cycles in, say, a new feature, a team can observe and address all the touchpoints, loops, interfaces, and delays throughout the organ- ization, reducing time to market by as much as 30 percent without compromising quality. We close this issue with “Mastering variability in complex environments.” The combination of semiconductors’ complexity and the pace of industry change make variability—a deep challenge to profitability—very difficult to manage. What can be done? The authors discuss a way of quantifying the impact of changes in lead time and utilization on variability that can help manufacturers manage that variability beyond what can be done with traditional methods. We hope these essays encourage you on your journey toward excellence. We invite comments at Harald Bauer Principal Ulrich Naeher Director Nick Santhanam Principal André Andonian Director Sri Kaza Associate principal
  7. 7. 5 Despite its moderate size, the semiconductor industry contributes disproportionately to growth in US labor productivity and delivers tremen- dous value to consumers. The industry, along with the electronics industry it does so much to power, contributed more than 25 percent of total US productivity growth from 1995 to 1999— more than any other sector. That four-year period outshined overall productivity growth from 1987 to 1995, according to an analysis published by the McKinsey Global Institute.1 Much of the tremendous growth seen in the electronics industry over the last three decades comes directly from the increasing power and decreasing price of semiconductors, a function of Stefan Heck, Sri Kaza, and Dickon Pinner Creating value in the semiconductor industry Moore’s Law.2 This performance improvement enables the electronics industry to continually produce devices and systems that are smaller, more powerful, and richer in features at lower prices. It has famously been noted that if the automotive industry had achieved similar improvements in performance in the last 30 years, a Rolls-Royce would cost only $40 and could circle the globe eight times on one gallon of gas—with a top speed of 2.4 million miles per hour. However, most chip makers capture only a small percentage of the tremendous value they create; consumers receive the lion’s share. Indeed, despite its large positive impact on overall economic growth, the semiconductor industry (excluding In light of increasing consolidation throughout the semiconductor value chain, companies that wish to succeed must move quickly to close capability gaps. 1 US productivity growth 1995–2000: Understanding the contributions of infor- mation technology relative to other factors, McKinsey Global Institute, October 2001. 2 According to Gordon Moore, a founder of Intel, the number of transistors that can be fitted into a single chip doubles roughly every two years, resulting in both faster perfor- mance and lower cost.
  8. 8. 6 McKinsey on Semiconductors Autumn 2011 Intel) destroyed approximately $47 billion in value for shareholders between 1996 and 2009 (Exhibit 1). To put that figure, and the signifi- cant disparity seen in the industry, into context, Intel alone created about $57 billion in value during that same time period. The economic challenges that the semiconductor industry faces can be attributed to a confluence of two factors: cyclicality, and rising costs in RD and on the capital-investment side of the ledger, due to the increasing costs of upgrading existing fabrication plants and building new ones. The cycle, while bad for the industry, is in some ways a blessing for underperformers, who have been able to stay in business because the profits they generate during a cyclical upturn enable them to sustain their operations during a downturn and attract funds for capital invest- ments beyond market requirements, which initiates the next cyclical downturn. Government interest in building semiconductor industries— most recently in China and India—accentuates this problem. As for RD, chip makers invest heavily, driven to meet the expectations of Moore’s Law: costs have Exhibit 1 Positive economic profit (EP)1 $ billion Negative EP The semiconductor industry, excluding Intel, destroyed $47 billion of value from 1996 to 2009. MoSC 2011 Value creation Exhibit 1 of 7 1Positive EP in each year of the time period. In addition, Intel had a positive EP of $57 billion during this period. EP is calculated as net operating profit less adjusted taxes – (capital charge, where capital charge is invested capital at previous year end × weighted average cost of capital). Source: Corporate Performance Center Semiconductor Database; McKinsey analysis 91 –47 91 –138 TSMC 14.3 Samsung 14.0 Qualcomm 13.6 Texas Instruments 9.5 Applied Materials 6.0 Mediatek 5.1 Linear 3.1 Maxim 2.4 Rohm 2.1 Analog Devices 2.1 Altera 1.6 Xilinx 1.4 KLA 1.4 Nvidia 1.4 Microchip 1.2 Synopsys 1.2 ASML 1.0 Others 10.0
  9. 9. 7Creating value in the semiconductor industry naturally risen along with the ever-increasing complexity of the chips. In addition, the investment hurdle for building a state-of-the-art chip fab continues to rise. All that said, it is important to remember that the $47 billion of destroyed value is an aggregate figure made up of many losers and several disproportionate successes. Indeed, in many segments, the top performer generates more than 100 percent of the total value. How do the top performers succeed? They implement operational- improvement programs for product lines that can hit acceptable targets for return on invested capital (ROIC), and judiciously divest those that cannot. Companies that wish to thrive must follow this example. They must optimize for ROIC rather than share or gross margin, a process that entails identifying improvement levers relating to each com- ponent of ROIC and designing initiatives targeted to each. Lean operations approaches, including best- practice manufacturing techniques, exert direct impact on ROIC and are therefore key levers in this first step. The companies that have successfully followed this two-step model have achieved improvements in ROIC in the range of 5 percentage points. Some companies have improved ROIC by as much as 20 to 30 percentage points. Understanding the sources of value destruction Although an analysis of income statements shows a number of profitable players in the semiconductor industry, most players are not able to generate economic profit; that is, their ROIC lags behind
  10. 10. 8 McKinsey on Semiconductors Autumn 2011 their weighted average cost of capital. Indeed, disaggregating the industry by business model and subsegment reveals that in most segments, only one or two players create value. As we have indicated, the industry as a whole has struggled to generate economic profit because three factors present unique challenges to chip manufacturers. Historically, the semiconductor industry has shown strong cyclical behavior. During a typical upturn of one to two years, most companies generate profits, which they use to sustain their operations during the down- turn. In addition, many players use their strong performance during an upturn to entice investors in the public markets or get new loans to fund capital investments; in many cases, governments subsidize these refinancings (Exhibit 2). But precisely because investment runs ahead of market demand in the upturn, the period is followed by a longer downturn or a very slow growth period, during which poor per- formers struggle. There is some evidence to suggest that both the amplitude and time frame of the industry’s cyclicality is moderating, but it is likely that some degree of cyclicality will remain. The skyrocketing costs of RD and the increasing amount of capital required to build a state-of- Exhibit 2 Sources of financing for poor performers1 1996 110 100 90 80 70 60 50 40 30 20 10 0 –10 –20 –30 1998 2000 2002 2004 2006 2008 2010 Financing continues to flow from private investors and governments as poor performers fail to deliver. MoSC 2011 Value creation Exhibit 2 of 7 1This includes the 59 players with the lowest average economic profit/revenue. Source: Compustat; Corporate Performance Center analysis Cumulative operating cash flow net capital expenditure Net debt financing Equity financing net of dividends and buybacks Performance improvement is contingent on change in economic behavior • Investors and governments cease to fund value-destroying players in the future • Players focus not only on the top line but also on operational efficiency $billion,annual
  11. 11. 9Creating value in the semiconductor industry the-art fab add to the industry’s economic challenges. Chip makers continue to pour money into RD as new designs and process tech- nologies become increasingly expensive to develop. In 2009, RD spending amounted to approx- imately 17 percent of industry revenue for semi- conductor companies (up from 14 percent a decade earlier) versus 3 percent for automakers, to take one example. The cost of building leading-edge fabs continues to increase as well; for example, the average 8-inch fab costs $1.6 billion to build, while a state-of-the-art 12-inch fab costs $3 billion to $4 billion. Similarly, the costs for developing process technologies on new nodes is increasing dramatically; for example, the average cost of developing a 90-nanometer logic process technology is approximately $300 million, while the cost of developing a modern 45-nanometer logic process technology is approximately $600 million, representing a doubling of spend in roughly five years (Exhibit 3). Exhibit 3 Integrated device manufacturers: company revenue required to sustain leading-edge fab investments Only Intel and Samsung can invest beyond 22nm 2009 semiconductor revenue, $ billion Intel 2.9 90nm 2004 65nm 2006 45nm 2008 90nm 2004 65nm 2006 45nm 2008 22nm 2012 22nm 2012 3.8 5.2 7.0 9.5 Sony ST NXP Samsung Freescale Infineon Texas Instruments Leading-edge fab investment Process-development cost Fewer logic integrated device manufacturers are able to sustainably invest in leading-edge nodes. MoSC 2011 Value creation Exhibit 3 of 7 1Nanometers. Source: iSuppli; literature search; McKinsey analysis Minimum-revenue- level assumptions • RD per product (fab investment/process development, $ billion): – 65nm:1 2.4/0.6 – 45nm: 3.3/0.7 – 32nm: 4.4/1.0 – 22nm: 6.0/1.4 • Node developed over 3 years • RD as 10–12% of revenue • Node introduced every 2 years 17.5 9.7 8.5 4.5 4.5 3.4 32.4 3.2 2.4 2.6 3.3 6.5 32.4 17.5 9.7 8.5 4.5 4.5 3.4 3.2 Revenue level required for sustainable leading-edge fab investment
  12. 12. 10 McKinsey on Semiconductors Autumn 2011 Exhibit 4 Capital spending/semiconductor revenue is decreasing . . . Criticalexposuresystemcost, $thousand Line width, nanometers . . . even though capital costs are rising % 1995 35 30 25 20 15 10 5 0 100,000 G-line I-line KrF ArF ArF-1 EUV 10,000 10,000 1,000 150mm 200mm 300mm 450mm 1,000 100 100 02000 2005 2010 2015 ‘Fab lite’ strategies have reduced capital expenditures, and at the same time, overall capital costs are rising sharply. MoSC 2011 Value creation Exhibit 4 of 7 Source: IC Insights; IC Knowledge In response to these higher costs, many semiconductor companies have resorted to “fab lite” strategies, outsourcing an increasingly large fraction of their chip production to dedicated manufacturing foundries. Although this has resulted in an overall net reduction of capital expenditures in the industry, from an average of approximately 27 percent of revenues (from 1996 to 2001) to approximately 20 percent of revenues (from 2002 to 2009), it has also led to intense cost pressure on chip makers that continue to handle all their manufacturing in-house (Exhibit 4). The shift of manufacturing to Asia has created additional cost pressures on those that have yet to transfer operations to lower-cost locations. Prices also remain under pressure in the industry as consumer applications become the main force driving the semiconductor market. The much higher elasticity of demand as prices decline has further accelerated the erosion of average selling prices. All these pressures are intensified by the shift in the end-user market to Asia. Furthermore, the lack of a “killer app” on the horizon—and the slower growth of traditional large, high-growth markets such as PCs and mobile phones—means that the economic pressures on the industry are not likely to abate anytime soon. Learning from the top performers A handful of semiconductor players have consistently generated a disproportionate amount of value in this industry. An analysis of the key attributes of these companies, as well as those of the leading players in other industries, sug- gests the two major lessons noted earlier for those who seek to capture economic profits in semiconductors: successful players work to improve ROIC where it can be satisfactorily
  13. 13. 11Creating value in the semiconductor industry improved, and they aggressively prune product portfolios of businesses that do not look likely to become sufficiently profitable. As far as ROIC is concerned, top performers focus on changing the dynamics and structure within a given segment as they seek to build leading positions early on. Acquiring and holding a market share of 40 percent or more within a segment enables companies to drive higher profits (Exhibit 5). Such companies typically have closer relationships with key customers, advanced RD processes that yield better innova- tion road maps (which are also more closely aligned with the key value drivers for their segment), deeper insight derived from having a more complete picture of where the market is going, and in many cases, a greater ability to maintain margins through downturns. To achieve this kind of performance, semiconductor companies must optimize ROIC by executing operational-improvement programs, including but not limited to making lean operational improvements, targeting profitability (rather than other measures), improving asset utilization, and tuning their capital-asset strategy (that is, make versus buy) to further improve return on capital. To target areas for improvement, a detailed ROIC tree can be used to disaggregate the components of revenue, cost, and invested capital and thus identify the main value-creation levers for each component. Exhibit 6 lists examples of value-creation levers and the impact that these levers help companies achieve. By helping companies implement lean- manufacturing techniques, we have assisted more than 10 semiconductor companies in increasing the throughput of their fabs by 20 to 30 percent (with minimal additional capital expenditure). Naturally, this has been a significant driver of improved ROIC, as well as incremental gross margin. These gains have been achieved by Exhibit 5 Averagereturnoninvestedcapital, 2007–09,% Market share, 2009 Lattice Freescale (DSP) AMD (MPU) Hynix (DRAM) Samsung (DRAM) Applied Materials (deposition) UMC TEL TSMC (foundry) Xilinx (PLD) Intel (MPU) Texas Instruments (DSP) 0 50 40 30 20 10 0 –10 –20 –30 20 40 60 80 100 A high segment market share enables companies to shape their future and earn higher returns. MoSC 2011 Value creation Exhibit 5 of 7 Source: Corporate Performance Center Semiconductor Database; iSuppli; Gartner Leading player No. 2 or 3 player
  14. 14. 12 McKinsey on Semiconductors Autumn 2011 Exhibit 6 Key levers to drive ROIC Companies have employed a number of strategies to achieve impact. MoSC 2011 Value creation Exhibit 6 of 7 1Return on invested capital. Revenue CostROIC1 Capital Strategic Tactical Fixed Variable • Develop products and drive efficiency and effectiveness in new-product introduction • Employ a new market-development strategy • Pricing: improve discipline and value communication • Sales-force effectiveness: optimize coverage and productivity of field sales force • Account profitability: realize value from investing in key accounts • Improve fab throughput and drive lean operations • Employ strategic sourcing focused on total cost of materials • Optimize consumption to reduce material usage • Optimize supply chain • Use fabless/“fab lite” strategy and optimize footprint • Improve capital-expenditure planning and purchasing strategy • Reduce general and administrative costs, optimize performance • Optimize RD spend/portfolio, rationalize products – ÷ + + maximizing overall equipment effectiveness, a technique that exposes all the losses attributable to bottleneck machines in a 24-hour period, thereby allowing companies to focus on reducing the largest losses. This technique was as effective in 4-inch, 5-inch, 6-inch, and 8-inch fabs (the older, trailing-edge fabs) as it was when deployed in leading-edge 12-inch fabs. In trailing-edge fabs, most of the improvements are captured from increasing the uptime of bottleneck machines, for example, by minimizing machine changeovers and setups and optimizing material handling to ensure that a bottleneck machine is never left idle. By contrast, in leading- edge fabs, many of the improvements come from reducing the process time of an individual wafer by tailoring the sequence of tasks of the bottleneck machine to a specific “recipe” (the unique flow of manufacturing process steps required to fabricate the wafer) and eliminating recipe redundancy. For example, dielectric thin-film deposition times can be decreased, with a corresponding increase in the throughput of deposition equipment, by reducing the thickness of excess dielectric material. This has the added benefits of increasing both the throughput of chemical-mechanical-planarization (CMP) machines (because less excess material is removed in the polishing process) and the lifetime of the CMP pads. Another lever that can help improve ROIC is pricing, and we recommend chip makers use value- based pricing and transactional pricing to drive revenue increases of 2 to 7 percent. Value- based pricing processes enable companies to set prices equivalent to the value perceived by
  15. 15. 13Creating value in the semiconductor industry customers by identifying the individual value drivers of a product, interviewing customers to understand the importance of each of these drivers to their purchasing decisions, understanding the degree of differentiation the company possesses with regard to each driver, and translating this value into price. Transactional pricing, by contrast, focuses on minimizing the leakage of value in the final price relative to the list price. This leakage is analyzed with regard to variance (differences in discounting or margin performance), slippage (deviations from established policies, guide- lines, or programs), and structure (suboptimal pricing structures, processes, or delegation levels, resulting in unnecessarily low net prices). Setting aside ROIC, the second main lever involves proactively managing product portfolios: investing in market segments that are growing, either organically or through acquisition, and divesting segments in which growth or margins are low. In reviewing its portfolio, a company may find that it includes some fast-growing businesses with high profit margins as well as other businesses in which the company has achieved limited suc- cess despite years of investment. Top-performing companies actively evolve their portfolios as markets mature or become less attractive. Rather than engaging in a price war to increase their share of a stagnating market, for example, they drop out of businesses that offer little hope of profitability (Exhibit 7). Several top performers have been particularly successful with this approach. Texas Instruments has divested more than 15 lower-growth, lower- Exhibit 7 Choice of market is the most important contributor to growth . . . Sources of growth Choice of market/ market growth Market-share gain MA Contribution to growth1 Average contribution for semiconductor peer group,2 2005–08, % . . . and companies’ performance in choosing markets differs widely It has become even more critical for semiconductor companies to focus on the right markets. Growth from choice of market Yearly growth attributable to choice of market, 2005–08, % MoSC 2011 Value creation Exhibit 7 of 7 1Only positive contributions to growth have been included in the analysis. 2AMD, Broadcom, Infineon, Intel, Mediatek, NEC, NXP, Panasonic, Qualcomm, Sony, ST, Texas Instruments, and Toshiba. Source: Annual reports; McKinsey analysis of granularity of growth 70 19 11 Top performer 9.2 Worst performer 1.6 5× Companies’ ability to identify the right markets to compete in has a significant influence on their total growth performance
  16. 16. 14 McKinsey on Semiconductors Autumn 2011 margin businesses in the past 15 years (including its DRAM and defense-controls units) to focus on the wireless business, as well as to develop a medical business. Qualcomm focuses on the large, high-growth wireless-handset market and, by controlling intellectual property such as the CDMA and WCDMA chip sets, is able to generate significant profits through licensing arrangements, creating an additional revenue stream that does not entail building chips. Applied Materials’ ability to enter key new growth segments (such as rapid thermal processing, copper deposition, and solar) while shifting its mix away from underperforming segments (such as implants) has enabled it to maximize profitability. As these examples illustrate, it is crucial for semiconductor companies to develop solid portfolio strategies and to actively manage their portfolios over time. Put another way, just as the technologies and processes in the fabs evolve, so must the composition of the corporation. The inability of many semiconductor companies to create value is one of the key factors driving consolidation throughout the industry’s value chain today. Indeed, as private-equity players set their sights on the industry, under- performing companies face a stark choice: they can either follow the lead of top performers and undertake initiatives to improve perfor- mance, thus helping shape the industry’s structure, or they can leave it to acquirers to step in and drive a new dynamic of value creation. Those that choose the former course must begin by evaluating whether they have the strategic, organizational, and operational capabil- ities to pursue a performance transformation. If such companies lack these capabilities but still wish to control their future, they must move quickly to close capability gaps before embarking on the journey. Stefan Heck is a director in McKinsey’s Stamford office, Sri Kaza is an associate principal in the Silicon Valley office, and Dickon Pinner is a principal in the San Francisco office. Copyright © 2011 McKinsey Company. All rights reserved.
  17. 17. 15 Gaurav Batra and Olivia Nottebohm Getting customers to say, ‘The price is right!’ In a world where too many companies still believe that ‘if we build it they will come,’ practitioners of semiconductor sales know otherwise. This article lays out the elements essential to extracting the most value for current products by effectively communicating the true value of those products to customers. Keeping the marketing and sales engines humming profitably is a cornerstone of all successful compa- nies. It is especially important in the semiconductor industry, where the leaders in each product seg- ment usually take most of the profits. Things often go wrong when companies feel their market share is threatened. Frequently, the first response of both leading and lagging players is to discount prices. Closer analysis, however, often reveals that this move needlessly dilutes value that could have been retained despite competitive pressure. In semiconductors, discounting is not just a strategy but an industry norm—a condition that has prevailed owing to an industry adaptation to extremely tight innovation cycles. That is, the larger issue underlying habitual discounting in semiconductors is the acceptance on the part of semiconductor companies that a dynamic built into the industry as a whole will always drive prices down. Companies therefore often fail to address and can even contribute to the shortfall by expect- ing nothing better. However, companies can begin to reverse this trend by revisiting the value proposition they are offering to customers, specifically to determine whether the true, unique value of their products is being communicated. This is where the journey to value selling begins. The value-selling approach We have devoted considerable research and drawn upon extensive engagement experience to create
  18. 18. 16 McKinsey on Semiconductors Autumn 2011 an approach to sales by which companies can better understand their existing value propositions, identify where these are failing them, and make the transition to a customer-centric approach that immediately demonstrates the full value of their products to customers. A value-selling approach allows companies to pursue and capture margin according to the end-to-end value provided to the customer, as opposed to the traditional cost-plus approach. Even in the semiconductor industry—with its engineering culture that is particularly comfortable with cost-plus pricing— most client executives have been pleasantly surprised to see the top-line impact possible from value selling, especially as it requires no changes to the existing product portfolio. In the first year, value selling can add 2 to 4 percent to average selling prices, a number that can grow to 6 to 8 percent in the second year if customer insights are fed back into the design of new products. Our original findings were based on practical experience. We interviewed dozens of one company’s end customers, asking each of them to allocate 100 points among the different factors in their process for making purchasing decisions. The great majority of those surveyed identified price as the most important factor in their final decision. Deeper analysis of those responses revealed, however, that some groups of customers actually cared as much or more about features than about price. It turned out that some customers were knowingly paying more for the client’s product than they would have for the next-best alternative. The discovery of this partly hidden preferential-buying behavior led to a conclusion that a sales approach that communicates a holistic view of value could positively affect the way that customers think about purchases. The transition to a value-based selling approach involves a fundamental change in existing sales approaches and marketing messages. The constituent tactical shifts of the approach are made based on deep-structure interviews with customers, as well as by working to identify the value of the company’s offerings. A company adopting this approach will also need to construct a set of new tools for the sales force and build value-selling capabilities in the workforce. Last, it must develop metrics to track sales-force performance over time. A formal transformation program is necessary to sustain the transition; the good news is that the scope can be either narrow or broad, focusing on a single product family or region, or encompassing a program that repositions a company’s entire product portfolio. Identifying value to the customer Value selling requires, at its base, an under- standing of the true value of the product to the customer. Most customers think of value as apparent value—that is, the benefit they receive directly from a purchase. They rarely consider indirect benefits, such as the positive or negative impact of switching costs, or the infrastructure savings that come from sticking to current product lines. In addition, a mind-set has been observed in both companies and their customers by which current prices are expected wholly to deter- mine future prices. Accordingly, unless the product changes, the price should rise only in line with inflation or if particular input costs increase. This generally leads companies to neglect the question of how the value of their products evolves over time. In all, there are four components to implementing a value-selling approach: developing a new approach to purchasing criteria, building a new set of tools to support the sales teams in the field,
  19. 19. 17Getting customers to say, ‘The price is right!’ developing training to educate sales teams on the new sales approach, and developing metrics and systems to track the sales force’s performance over time. 1. Uncovering customer purchasing criteria The first step in the new direction is a diagnostic analysis aimed at uncovering the key criteria that customers use to make purchasing decisions. This may seem counterintuitive, as company sales and marketing teams would be expected to know these criteria already. Typically, top salespeople do know exactly what matters to their customers, but their less skilled colleagues may not; best practices are not always shared or institutionalized in a form that is useful to less experienced account managers. We begin with interviews to determine the elements that matter most to customers and to understand how these are prioritized. The exercise is highly qualitative, requiring dozens of interviews throughout the customer base. The diagnostic yields three results: a list of factors that are most important to customers, a ranking of those factors in order of importance, and, critically, an assessment of company performance against those value drivers in any particular product category. To go beyond articulated preferences, we conduct a conjoint analysis to quantify value drivers at both the individual product level and the broader company level. Typical findings from diagnostics of the sources of value at the product level have included these attributes: • Superior performance with regard to power efficiency, speed, graphic resolution, and so on • Ease of use and ability to design in, without many additional modifications • Advantaged size and packaging to enable greater bill-of-materials integration • A better set of built-in capabilities to reduce the need for additional discrete peripherals, board design, or programming At the company level, we have found that cus- tomers derive value from the following elements: • The reputation of the provider—for example, the value of saying “powered by x” or “includes y processor” • Strong development and technical- support capabilities • Advantaged supply-chain and manufacturing capabilities, resulting in higher product availability, better quality assurance, and superior reliability • Developer tools and well-established code libraries—for instance, a network of independent software vendors (ISVs) for microprocessors In a value-selling pilot, one customer said, “If it saves me development cost and improves my time to market by x percent, I am not going to go for a cheaper device.” This remark neatly sums up the reasoning behind value selling and the source of its impact. 2. The value-selling tool: Communicating quantifiable value to your customer Once a company understands the real value of its products to its customers, it must develop
  20. 20. 18 McKinsey on Semiconductors Autumn 2011 easy-to-use tools to guide the sales team in its work. The tools are often mechanisms for quantifying the impact of relevant value drivers and simplifying any calculations the sales team must make. If we consider the example of a company that can deliver a particular product faster than a competitor, its sales force must be able to quantify the value to the client of faster time to market in the specific marketplace into which the product is being sold. A calcu- lation of such specificity can rarely be performed in an ad hoc manner by a sales team in the field. The team therefore needs an analytic tool that can systematically identify the value created for the customer by the company’s product versus the next-best alternative. This identifica- tion will come in the form of an assessment that clearly captures the incremental value delivered by the product vis-à-vis competitor offerings (Exhibit 1). The tool must be easy to use, and its analytic mechanism dynamically responsive to the needs of the field. The salesperson must be able to enter a few essential variables reflecting the specific interest of any Exhibit 1 Research shows that customers make clear value distinctions for many products. MoSC 2011 Sales and marketing Exhibit 3 of 4 Source: Customer interviews; McKinsey analysis Product value vs NBA, $End device Value/NBA Client product value Next-best alternative (NBA) Product 1 3.6x7.55 2.10 Product 4 1.7x13.00 7.50 Product 5 1.2x4.10 3.50 Product 2 2.6x7.52 2.90 Product 6 1.1x6.80 6.20 Product 7 1.0x9.00 9.00 Product 8 Wide range in value over NBA price 1.0x2.00 2.00 Product 3 1.8x0.90 0.50
  21. 21. 19Getting customers to say, ‘The price is right!’ given customer and obtain an assessment of the value of the product to that customer. Much technical and experiential expertise will be incorporated into the value-selling tool, and this input must be regularly updated with product, customer, and market data. The tool’s purpose, however, is a simple and visible demonstration of the power of the value- selling approach. This power lies in value selling’s ability to communicate a quantifiable value, based on the drivers that are most important and therefore worth the most to the customer relative to competitive offerings. The approach is entirely oriented to allowing the salesperson to take a customer-centric view. It enables salespeople to provide in a dynamic fashion the information needed by a customer’s line-of-business leader or procurement officer in order to make the winning case for their product to his or her boss. The salesperson thus delivers to the customer a transformed value proposition. The message becomes “I’m getting a product worth two to three times its price,” rather than “I’m getting a product 10 cents cheaper than the next guy is.” Not all customers are the same: some may share a consistent set of value drivers, while others have variable priorities or find different value in comparable attributes. Good value-selling tools empower salespeople to identify the types of customers they are dealing with and to generate quickly the most convincing value proposition for them. The sales force can adapt to different types of customers without having to improvise value propositions for each customer visit (Exhibit 2). Exhibit 2 What customers value differs significantly according to the segment they fall into. MoSC 2011 Sales and marketing Exhibit 4 of 4 A “Sparrow” Cannot benefit from bulk of what product can offer D “Eagle” Pushes the limits— demands maximum performance on all metrics C “Hawk” Values 2 of 3 attributes; primary concern is performance over costs; willing to pay a lot of money B “Crow” Values only 1of 3 attributes but willing to pay a premium for that value Low Design intensity Functionality of chip Low High Low High High End-user characteristics Dynamic Static
  22. 22. 20 McKinsey on Semiconductors Autumn 2011 3. Building value-selling capabilities in the sales force The value-selling approach represents a new way for the field sales force to relate to its customers. How can you bring this new approach to life for them? Here we believe there are three critical success factors: first, leaders and the sales force must co-create the solutions; second, leadership must visibly model the new approach; and third, salespeople should be allowed to practice new skills in a safe, non- customer-facing environment. Co-creating solutions The more the experienced members of the sales force are engaged in the quantification process— that is, in generating the underlying numbers that drive the calculations made by the tools the sales force will use—the more effective the result. There are two reasons for this: first, experienced salespeople understand the dynamics in the marketplace and can use their expertise to improve the tool, and second, they must believe in the calculations that drive the value-selling tools they are being asked to use. Modeling the approach The second success factor is no less important than the first. The sales force must feel the inspiration from above. The head of sales for the company must participate in the effort and personally emphasize the need for value selling. Practicing the approach Finally, we have found that it is crucial to create a low-stress environment, in which sales- people can practice free of exposure to customers and fears of internal evaluation. Every time we have conducted such sessions, we have discovered that recording the salesperson’s cus- tomer approach and then reviewing it with them helps prepare them for even the toughest customers. When they see themselves working—and improving—in the new way, sales- people truly internalize the arguments they must make and embrace the value quantifications they will put forward. Early practice often becomes a learning oppor- tunity, in which the shortcomings of the existing approach are revealed and understood as such. Salespeople usually begin by talking in cost-plus language, rather than adopting a customer perspective. A salesperson may fail to offer quan- tified comparisons with competitive products, even when supporting data are at the ready. The key is to keep trying: with practice, the new way of working begins to stick. Value selling requires, at its base, an understanding of the true value of the product to the customer
  23. 23. 21Getting customers to say, ‘The price is right!’ 4. Locking in change by tracking performance We cannot overstate the importance of metrics to track performance. Simply put, what gets measured gets done. Most successful transfor- mation programs have an engaged program- management office that is aided by efficient IT systems to track progress and assess sales- force behavior on a regular basis. The most successful value sellers use a sequence of workshops, scheduled to coincide with the run-up to new sales campaigns or new product launches, to maintain momentum. These sessions allow companies to share best practices and celebrate successes. In the medium term, value selling can improve average selling prices substantially, reinforcing the approach. McKinsey has introduced its value-selling approach in a number of industries, where it is increasingly becoming a key success factor. We strongly believe that this approach has a great deal to offer the semiconductor industry, where customers want to be told precisely what value is being created for them and to know how a product will help them be more successful. In a world where products do not sell themselves, value selling is demonstrating that it can make the crucial difference for companies. Gaurav Batra is a consultant in McKinsey’s Silicon Valley office, where Olivia Nottebohm is a principal. Copyright © 2011 McKinsey Company. All rights reserved.
  24. 24. 22 McKinsey on Semiconductors Autumn 2011 Since the late 1980s, the Chinese government has made efforts to build an indigenous semiconductor industry by providing financial incentives, devel- oping talent and technology, and crafting alliances with global players. And though the country has assumed a central role in the manufacture of many computing and consumer-electronics products, its role in the semiconductor sector has remained surprisingly limited. In the industry value chain, China has a strong share in only the assembly-and- test and back-end-manufacturing segments. Aside from these two (admittedly considerable) areas, the country is largely missing from semiconductor league tables. In fact, today China is primarily a consumer of semiconductors, rather than a producer of them. Sri Kaza, Rajat Mishra, Nick Santhanam, and Sid Tandon The challenge of China The country’s semiconductor trade association published a report in March 2011 that estimated that the Chinese semiconductor market accounted for fully 33 percent of global supply. The share of those chips used in domestic products accounts for 15 percent of the global semiconductor market. The remaining share is installed in a wide range of export goods. Furthermore, our research indicates that Chinese companies influence the design and other elements of just 1 to 2 percent of finished chips. It would be logical to expect that a country of China’s size would be a leading stakeholder in discussions about technology standards and the designs for next-generation platforms, but that is not the case. Despite consuming 33 percent As barriers to Chinese competition weaken, local and foreign semiconductor players must consider issues such as intellectual property and knowledge transfer to fully capture opportunities in this important market.
  25. 25. 23 Exhibit 1 Chinese foundry TSMC 0.13 1 VIS 0.20 0 Dongbu Electronics 0.25 0 I-NEC 0.25 0 ALTIS 0.18 0 Grace 0.18 0 SilTerra 0.18 0 SSMC 0.18 0 HeJian 0.25 1 China Resources 0.50 3 Jazz 0.25 1 Tower Semiconductor 0.18 1 FAB 0.35 4 EPISIL 0.50 3 ASMC 0.50 2 SMIC 0.18 0 UMC 0.15 1 Chartered Semiconductor 0.18 0.045 0.09 0.09 0.13 0.13 0.13 0.09 0.13 0.15 0.25 0.13 0.13 0.13 0.25 0.25 0.09 0.045 0.045 0 2 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3 2 1 Company 2009 nodes, microns Mainstream1 Leading edge 6” 8 2 2 2 1 1 1 1 1 1 1 2 2 2 1 5 7 5 8” 12” Number of fabs Chinese foundries lack leading-edge technologies because of export controls. MoSC 2011 China Exhibit 1of 5 1“Mainstream” includes nodes utilized in more than 50% of the foundry’s total capacity. Source: iSuppli, H1 2009; World Fab Watch 2009; Wassenaar Arrangement Web site, Category 3 list; Semiconductor Equipment and Materials International; Taipei Times • Until 2010, controls prevented the export of 90nm manufacturing technology to China • Until 2010, Taiwan restricted the export of 180nm manufacturing technology to China • In 2010, the Wassenaar Arrangement was updated: controls now prevent 65nm manufacturing technology from being exported to China • In 2010, Taiwan signed an agreement with China (the Export Promotion and Cooperation Agreement) that allows the export of manufacturing technology that is 2 generations behind leading edge The 1996 Wassenaar Arrangement puts export controls on manufacturing technology . . . . . . which has prevented Chinese companies from accessing 65-nanometer (nm) node technology of the global market for semiconductors, Chinese companies claim less than 4 percent of global revenue in the lucrative segments of semiconductor design and front-end manufacturing. There are four reasons for this state of affairs. First, China exerts little influence on semiconductor design and selection in major product categories such as mobile phones and laptop computers. The majority of design decisions for these goods are made by global champions—such as Nokia, Acer, and Apple—in their home countries, at the headquarters level.
  26. 26. 24 McKinsey on Semiconductors Autumn 2011 Second, the home countries of major semicon- ductor companies ban the export of leading-edge manufacturing technologies to China. Both the United States and the island of Taiwan prohibit the export of equipment used to manufacture sub-65-nanometer process technologies, which leaves mainland Chinese foundries two generations behind the current 32-nanometer standard (Exhibit 1). Third, concentrated clusters of semiconductor excellence failed to fully develop in China. Instead of focusing investments on one location, as did the island of Taiwan with Hsinchu Science Park, the Chinese government made invest- ments in multiple provinces, setting up semicon- ductor fabrication plants as far north as Jilin and Dalian, as far south as Shenzhen, and as far west as Chengdu. In all, fabs capable of producing more than 1,000 wafers per month are spread across 19 cities. Because the industry was so fragmented, government support did not lead to the formation of a vibrant semiconductor ecosystem in any single location. Fourth, and perhaps most important, foreign players own most of the intellectual property throughout the semiconductor value chain. Applied Materials, for instance, dominates manufacturing equip- ment, while Intel, Nvidia, and Qualcomm control key parts of integrated-chip design for microprocessors, video cards, and mobile handsets, Exhibit 2 Lack of intellectual property and know-how remains the only barrier to increased competition from Chinese semiconductor players. MoSC 2011 China Exhibit 2 of 5 Source: iSuppli; Databeans Barriers are weakening End-system design in China, for China Declining share of leading-edge nodes Renewed focus on clusters of excellence Details Increasing end-user consumption in China is likely to drive local system design • ZTE became the No. 5 player in mobile handsets in 2010 • Huawei is a top 3 player in all major telecommunications-equipment segments • Lenovo is the No. 3 PC vendor in the world The effect of Moore’s Law on the global semiconductor market is declining • Leading-edge nodes now represent 14% of total demand for logic chips and microcomponents, making access to manufacturing technology less important • Several large segments, such as analog integrated circuits ($42 billion in 2010) and microcontrollers ($18 billion), are using older technology Several Chinese cities are beginning to attain critical mass as clusters of excellence • Shenzhen, Chengdu, and Dalian have made significant progress • Texas Instruments and Freescale Semiconductor set up manufacturing plants in Chengdu • Intel set up a 90-nanometer fab in Dalian Issues related to intellectual-property know-how are the only major roadblock
  27. 27. 25The challenge of China respectively. Owning the intellectual property means these foreign players also garner the lion’s share of revenues. In the front-end-manufacturing segment, non-Chinese players (for example, Samsung, Intel, and Hynix) earn 96.3 percent of all revenues. In design, foreign players earn 96.1 percent of revenues. Even in the silicon segment, 93.0 percent of revenues go to non- mainland-Chinese companies. China has a decent share in only two areas, back-end manufac- turing and assembly and test, where Chinese companies earn 28.6 percent of total segment revenues. Taken together, these four hurdles have made it difficult for Chinese semiconductor players to compete in the last decade. However, three of those four barriers are now weakening, and with recent events likely to serve as a tipping point, we believe the lack of intellectual property and know-how is the remaining impediment to Chinese semiconductor players’ progress. This portends significant shifts in the international semiconductor situation (Exhibit 2). The emergence of a Chinese middle class is creating a domestic industry—one with export ambitions The first barrier—the modest influence China exerts on semiconductor design and selection in major product categories—is eroding as a robust domestic market emerges, particularly because first-time consumers of major product categories that use semiconductors do not need leading-edge products. As a consequence, a substantial “built in China, for China” market is taking shape. To get a sense of the scale of this market, consider the following facts: 26 percent of all automobiles sold in the world in 2010 were sold in China. Chinese citizens bought 19 percent of the global PC supply last year and accounted for 18 percent of LCD-TV sales. In the robust global market for mobile handsets, the Chinese commanded 14 percent of unit sales in 2010. And Chinese companies are leveraging their domestic scale to sell outside of China, thereby shaking up league tables further in a number of industries. Lenovo, for example, is now the third-largest vendor of PCs in the world. ZTE became the fifth-largest handset manufac- turer in the world in 2010. And Huawei has become a top-three player in all major segments of the telecommunications-equipment market. China’s emergence is significantly enabled by a declining need for ever-increasing processing speed. As the semiconductor industry moves closer to the physical limits of silicon, fewer devices are relying on truly leading-edge technologies. In fact, leading-edge nodes now represent only 14 percent of total demand for logic chips and microcomponents. There is, consequently, generally less pressure to have state-of-the-art manu- facturing technology (Exhibit 3). This opens the door for Chinese semiconductor players. Certain segments of the market have found success using technology that is one or two generations behind the leading edge. For example, analog inte- grated circuits and microcontrollers (which account for $42 billion and $18 billion in revenues, respectively) are leveraging process technology that is at least two years old. The proliferation of devices powered by less-than-cutting-edge chips means that the playing field for Chinese semiconductor manufacturers is much more level than ever before. Even if consumers in China become less willing to settle for second-best technology as their affluence grows, share is unlikely to shift decisively back to the West. Chinese semiconductor companies are developing process technologies
  28. 28. 26 McKinsey on Semiconductors Autumn 2011 more quickly. SMIC has now achieved the same two-year development cycles as industry leaders. Even though the company may be at a disadvantage due to Western export controls, it achieved stable output at the 65-nanometer level in 2010 and is ramping up additional capacity in 2011. And SMIC’s 65-nanometer fabs are running at 95 percent capacity, indicating that there is intense local demand for these chips. So the emergence of a local market and the apparently limited effect of Western export controls mean that the first two barriers to a significant Chinese presence in all segments of the semiconductor industry are coming down. The third barrier is also falling, because clusters of excellence are finally coming together in China. Several cities, including Shenzhen, Chengdu, and Dalian, have developed expertise in the local workforce, reached a critical mass in number of fabs, and connected with relevant suppliers nearby. A sure sign of this evolution is that Texas Instruments and Freescale Semiconductor have both opened manufacturing plants in Chengdu, and Intel has set up a $2.5 billion 90-nanometer fab in Dalian. Looking ahead to the coming decade, it is important to note that China has the world’s most compre- hensive, well-funded, and ambitious technology- Exhibit 3 Leading-edge nodes are only a small share of foundry volume. MoSC 2011 China Exhibit 3 of 5 Total foundry capacity per node, 300mm equivalent KWPM1 2,000 1,500 1,000 500 0 ≤32nm168 327 322 307 78 45nm 65nm 90nm 130nm 180nm 250nm 350nm ≥500nm 2004 2005 2006 2007 2008 2009 2010 20112 20122 20132 20142 1Thousands of wafers per month. 2Estimated. Source: Gartner, converted from 200mm to 300mm scale with 8” equivalent to 2.25
  29. 29. 27The challenge of China industry policy, and the semiconductor sector is 1 of the 16 sectors into which stakeholders want to make significant inroads. The country’s industrial policies for semiconductors are already beginning to show results as domestic end-to- end value chains emerge: for example, in wireless- communications semiconductors, an end-to-end value chain has developed among SMIC, HiSilicon, Huawei, China Mobile, China Unicom, and China Telecom. Similarly, in wireless systems on a chip, the domestic value chain consists of Taiwan Semiconductor Manufacturing Company (TSMC), Spreadtrum, Huawei, Tianyu, China Mobile, China Unicom, and local consumers. With three of the four barriers weakening, the lack of intellectual property and know-how is the only significant barrier remaining. While the Chinese have found many ways to acquire the intellectual property needed to establish domestic industries, challenges related to complex- ity and materials science in semiconductors are more burdensome than in other fields. Acquiring intellectual property and know-how will thus be crucial for Chinese players as long as the semiconductor sector remains a priority industry for government development programs. It should be noted that China has made multiple attempts to entice foreign players to transfer technology, for example, licensing Geode microprocessor-design technology from AMD. What does this mean for a strategic China engagement model? As the Chinese government increases efforts to develop the industry, it will likely offer more promising incentives for semiconductor companies to do business in China. This creates a dilemma: it will be difficult for foreign companies to compete from outside the country as their competitors establish beachheads there, but at the same time, the Chinese endgame is clearly the transfer of intellectual property and know-how to allow Chinese companies to compete globally— that is, not just to compete for the emerging local market currently owned by Western players, but to turn around and challenge Western players on their own turf. A similar scenario played out in the mid- to late 2000s, when the Chinese government launched a major policy initiative to promote the high- speed-rail industry. Seeing a $50 billion market, many foreign players, including Kawasaki, Siemens, Bombardier, and other companies, expressed interest. In 2004, several joint ventures were set up between foreign and local rail companies. While Siemens refused to transfer intellectual property to its joint-venture partner without adequate compensation, Kawasaki and one other player agreed to transfer signifi- cant intellectual property to their respective partners on less demanding terms. As classic game theory would predict, had all three players sold into China on similar terms, the $5.2 billion in potential reward would have been divided among the three equally ($1.7 billion for each, as seen in the top-left box in Exhibit 4). Since, however, Kawasaki and one other player agreed to Chinese terms on intellectual property but Siemens did not, it seemed likely that the two companies that shared IP would split the market equally. But Siemens felt it had little choice but to set up a joint venture including intellectual-property transfer to claim its share of revenues, so another scenario from the initial game-theory projection played out: each of the three players divided their share of the $5.2 billion market equally, and then split that amount with their Chinese partners. However, at the three-year mark, all the local joint-venture partners, having carefully
  30. 30. 28 McKinsey on Semiconductors Autumn 2011 incorporated key intellectual property from the foreign players, began launching indepen- dent products. Since 2007, these products have attracted $20 billion in orders from various state-owned enterprises; foreign players have not won any orders at all. This cautionary tale is not presented as definitive proof that the joint-venture structure is flawed irremediably. Rather, we mean to suggest that other structures must be energetically reviewed; companies should consider options that do not include the transfer of intellectual property. For instance, a number of leading multinational companies have adopted an “innovate with China” approach, which consists of launching RD centers in China that focus on developing technologies for the Chinese market. General Electric, for example, established a China RD center that focuses on developing products in line with local market demand and stated government priorities, such as rural health care and sustainable development. Siemens has a similar center working on LED lighting products and low-cost medical equipment. Each product from these centers is tailored to the Chinese market and could potentially be sold in other developing Exhibit 4 Classic game theory can be used to predict potential outcomes of partnerships in Chinese high-speed rail. MoSC 2011 China Exhibit 4 of 5 Source: New York Times; Financial Times Once Kawasaki and another foreign player agreed to joint ventures, Siemens had to do so as well Potential rewards, 2004–06: total orders of $5.2 billion All 3 players get equal share of $5.2 billion market and keep 100% of revenue Player with joint venture is preferred supplier and gets entire market; $5.2 billion revenue is split with joint-venture partner All 3 players get equal share of $5.2 billion market, but they must split revenue with joint-venture partner Player with joint venture is preferred supplier and gets entire market; $5.2 billion revenue is split with joint-venture partner Sell into Chinese market Local joint venture with intellectual-property transfer Actions of Siemens Actions of foreign players such as Kawasaki Sell into Chinese market Local joint venture with intellectual- property transfer 1.7 1.7 0.9 0.9 0 2.6 2.6 0 $ billion for Siemens $ billion for foreign players such as Kawasaki Win-win Stable state
  31. 31. 29The challenge of China markets. This approach serves to limit the exposure to intellectual-property risks to technologies or products developed in China (Exhibit 5). More broadly, there are a few simple steps that foreign players can take to boost their chances of success in the Chinese market. Keys include developing a go-to-market approach that addresses the problems of Chinese customers, nurturing strong relationships with large state-owned enter- prises, and presenting an innovative in-channel model to take advantage of unique characteristics of the market. Four strategic questions to consider Until now, foreign players have focused on protecting their intellectual property and know- how by selling finished chips into China. One common tactical approach is known as price customization; companies offer special product numbers and packaging, and although product performance is slightly lower, the goods cost less. While this approach meets basic market requirements, it creates an opportunity for local players; they can add features and differentiate themselves significantly. To head off that threat, many foreign semiconductor players Exhibit 5 Reviewing joint-venture structures can help avoid the prisoner’s dilemma, as in this electric-vehicles scenario. MoSC 2011 China Exhibit 5 of 5 Potential rewards, 2015–20: total potential orders of $4.5 billion1 All 3 players get equal share of $4.5 billion market and keep 100% of revenue Player with joint venture is preferred supplier and gets entire market; $4.5 billion revenue is split with joint-venture partner All 3 players get equal share of $4.5 billion market, but they must split revenue with joint-venture partner Is innovating in China, for China a better alternative? Player with joint venture is preferred supplier and gets entire market; $4.5 billion revenue is split with joint-venture partner Sell into Chinese market Local joint venture with intellectual-property transfer Actions of semiconductor company A Actions of semiconductor companies B/C Sell into Chinese market Local joint venture with intellectual- property transfer 1.5 1.5 0.7 0.7 0 2.3 2.3 0 $ billion for semiconductor company A $ billion for semiconductor companies B and C Win-win Stable state 1The Chinese government set a goal of 5 million electric cars in China by 2020; $900 in semiconductor content per hybrid or electric car. Source: New York Times; Financial Times [[Using bars t indica $ billio Ok? Is correc
  32. 32. 30 McKinsey on Semiconductors Autumn 2011 A combination of policies designed to enable large, next-generation end-use markets for semiconductors, together with procurement policies meant to drive indigenous innovation, is likely to create a strategic dilemma for semiconductor companies looking to sell into China. China has launched ambitious policy initiatives to develop large domestic markets for specific next- generation technologies: cloud computing, the “Internet of Things,” and hybrid and electric vehicles. These three markets combined represent tens of billions of dollars of market opportunity in China for semiconductor companies. The Chinese government is also increasingly emphasizing indigenous innovation in government procurement programs in order to reduce the country’s dependence on foreign technology. In November 2009, several Chinese government agencies announced six categories of products that would be directly affected: computer and application devices, communication products (thought to include mobile phones), modern- ized office equipment, software, “new energy and equipment,” and energy-efficient products. China’s 12th five-year plan also reinforces the drive to promote domestic innovation in these areas. Taken together, these policies and a number of stimulus programs may have significant implications for the semiconductor industry. These next- generation technologies and categories of products Indigenous innovation and next-generation markets for semiconductors are expected to be growth drivers for Western semiconductor players in the decade ahead. There is a real potential for Chinese companies to emerge in these areas, as current players have not established clear leadership positions in these applications. China has not yet tied the indigenous-innovation policy to its policies for these next-generation markets. But there is a real possibility that it will. And any move in that direction would create a strategic dilemma for semiconductor players, which are, frankly, counting on driving significant future growth from these three areas (exhibit). Simply responding to the challenge of establishing a presence in these areas by creating individual initiatives will not be sufficient. This is a matter that should rise to the highest strategic level for any company that wishes to be a player in these markets. A good place to start would be to understand the implications of potential government and competitor moves, and to develop a response that will accommodate each.
  33. 33. 31The challenge of China have begun designing products for China, in China, yet they remain wary of the risks of transferring intellectual property and know-how. From a strategic perspective, there are four key questions that semiconductor companies must answer to successfully address the oppor- tunity in the Chinese market. The first question concerns the engagement strategy for intellectual property and know-how. Simply put, what is the best way to use intellectual property in China? Two common strategies are to sell into China while keeping intellectual property in-house and to launch a joint ven- ture with an agreed-upon transfer of intellectual property. However, several other options exist. Companies could launch indigenous development centers in China, which will develop key technologies for the unproven, next-generation markets likely to take off should they become widely adopted in China. Another option is for Exhibit The semiconductor industry may face challenges related to intellectual property for next-generation applications. MoSC 2011 China sidebar Exhibit 1 of 1 The indigenous-innovation policy . . . • An “indigenous innovation catalog” of domestically developed technologies was created: approved products are to be given preferential treatment in state procurement • Initial focus areas include 6 high-tech industries: targets include computing, networking, and energy efficiency • The goal is to move from “made in China” to “innovated in China”: the country wants to reduce its dependence on foreign technology to 30% from its current level of 50% . . . could have significant implications when applied to large, next-generation markets • Cloud computing – Policy initiative launched in 2010 – Trials will take place in 5 cities – Key goals include developing core technologies and formulating standards • “Internet of Things” – Policy initiative launched in 2011 – The goal is to develop domestic leaders in the industrial value chain – Stakeholders also seek to provide support to develop standards • Hybrid and electric vehicles – Policy initiative launched in 2010 – The aim is to make China a leader by 2020 – The country seeks to develop 2–3 companies as global leaders in key technology areas This may result in a strategic dilemma for the semiconductor industry
  34. 34. 32 McKinsey on Semiconductors Autumn 2011 companies to partner with local downstream players, such as automobile manufacturers or even financial investors. The right way to frame this strategy is at the individual product-line level, not the business-unit or company level. A robust China strategy may include a number of different approaches used throughout the product portfolio. After determining a strategy, semiconductor players can derive a proper operating model. A carefully crafted operational strategy will focus primarily on competitive activity, a proper understanding of the level of capital investment required, and active government relations. The Chinese government is not monolithic; there are national, provincial, and local stakeholders with whom to negotiate and build longer-term relationships. Managing those relationships is crucial in accessing government contracts and the Chinese market at large. A third key question involves assessing the impact of the competitive environment (as regards both Chinese and foreign players) on a company’s overall China strategy. A competitor selling finished chips into the Chinese market will face circumstances that differ from one investing in local RD capacity or transferring intellectual property and know-how to a local partner. Might a Chinese player pursue intellectual prop- erty and know-how by acquiring a weaker competitor? What role, if any, will the Japanese play in the competitive situation? War- gaming the scenarios can help companies make necessary adjustments. The last important question involves asking how a company’s short- and medium-term strategy will differ from its long-term strategy in the country. Certain tactical choices may be right in a 6- to 12-month time frame, but priorities are likely to shift over a number of years. If the goal is to establish a large local RD presence from the outset, for instance, it may be valuable to adopt a long-term view from the very first day. Smaller commitments will call for different strategic approaches. Over the next five years, cloud computing, the Internet of Things, and electric vehicles are likely to be three of the strongest pools of growth for the global semiconductor industry. The Chinese government has launched a slate of initiatives aimed at developing those markets. As a result, China represents an increasingly important market for global semiconductor companies. However, the comprehensive policies of the Chinese government also indicate that the country intends to develop players who will compete in the top tier of the semiconductor industry. Three of the four barriers to China’s ability to compete are weakening, and the country is ramping up innovation in trailing-edge technology. Western semiconductor companies must determine their strategic posture now. A careful intellectual-property strategy and an oper- ational strategy closely aligned with it will be necessary to develop and hold on to key intellectual property—and thus prosper alongside Chinese players in the increasingly competitive global market for semiconductors. Sri Kaza is an associate principal in McKinsey’s Silicon Valley office, where Nick Santhanam is a principal and Sid Tandon is a consultant. Rajat Mishra is a consultant in the San Francisco office. Copyright © 2011 McKinsey Company. All rights reserved.
  35. 35. 33 Ulrich Naeher, Sakae Suzuki, and Bill Wiseman The evolution of business models in a disrupted value chain The progress predicted by Moore’s Law has slowed in recent years. Players across the semiconductor value chain must adjust their approaches to compete as the industry continues to evolve. Over the past decade, the growing importance of specialization and scale in semiconductors has led to a breakup of the value chain and the establish- ment of a “winner takes all” dynamic in many market segments, as noted in “Creating value in the semiconductor industry” (p. 5). Scale has become essential, as technical evolution in line with Moore’s Law requires larger and larger investments in RD each year. Specifically, the pursuit of smaller gate sizes, larger wafers, and competitive scale has resulted in an increase of about 20 percent in investment per year in leading-edge technology nodes. As a result, only a handful of companies—such as Intel, Samsung, and Taiwan Semiconductor Manufacturing Company (TSMC)— can keep up in the technology race. Design costs, measured on a project basis, have exploded as well, resulting in a reduction of new designs (Exhibit 1). It is no surprise that Intel stands out as the winner in microprocessor units (MPUs), Texas Instruments in diversified integrated device manufacturers (IDMs), and TSMC in foundry; Samsung and Toshiba are arguably the winners in memory. All other players, including most IDMs, net out with either zero or negative cumulative economic profits from 1996 to 2009. Across the industry, semi- conductor players destroyed a combined $140 billion in value. However, not every segment conforms to this Darwinian model; fabless players and segments
  36. 36. 34 McKinsey on Semiconductors Autumn 2011 such as analog IDMs are two examples of busi- nesses that are less ruthlessly competitive. In fact, the progress predicted by Moore’s Law has slowed in many segments of the semiconductor industry. Given this context, we examined ways in which the semiconductor value chain might evolve and explored how current players might adapt in order to compete. We begin by looking at the changes occurring in the fabless segment. Next, we turn to front-end fabrication, the segment that drove the technical developments that enabled the kind of advances predicted by Moore’s Law. Finally, we address back-end fabrication, where the miniaturization race seems to be shifting the assembly-and-test segment. Fabless design: Players adopt a range of successful models Over the last decade, fabless players have continued to gain ground, outpacing IDMs and claiming more than 20 percent of the market. Despite some scale in high-end design, there is no overarch- ing winner-takes-all dynamic in this corner of the industry. In fact, as noted in “Creating value in the semiconductor industry” (p. 5), there are far more fabless companies generating economic profits than there are profit-generating companies in manufacturing-related business domains. At first glance, one might conclude that fabless players create value because they require less capital investment. However, we find these companies win by establishing dominance in specific applications rather than across applica- Exhibit 1 There are fewer design starts, particularly on newer advanced technology. MoSC 2011 Moore’s Law Exhibit 1 of 5 1Integrated circuit. 2Application-specific standard product. 3Application-specific integrated circuit. Source: Global Semiconductor Alliance; Morgan Stanley; McKinsey analysis Number of logic IC1 design starts 12,000 10,000 8,000 6,000 4,000 2,000 0 ASSP2 ASIC3 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
  37. 37. 35The evolution of business models in a disrupted value chain tions. Overall, three distinct business models have succeeded in the fabless space: innovators, fast followers, and mature-market attackers. The innovator model is exemplified by leading players such as Qualcomm. These companies invest in continuous innovation for new applications, and they constantly expand their core intellectual property. Their efforts focus on unmet needs in the marketplace that come with large potential demand, and their explicit aim is to provide targeted semiconductors at the scale required to recoup RD costs. But being first to the market is not a must for fabless players. Broadcom is a good example of a fast follower. Instead of gambling on untested market potential, fast followers pick large, rapidly growing markets and quickly develop intellectual property to enter certain segments. They position themselves as presenting an integrated solution that is a lower-cost alternative to the market leader, with a streamlined business structure. The third model, the mature-market attacker, is best illustrated by MediaTek. It may appear quite similar to a fast follower at first glance. However, such companies wait until an application area has reached significant global volume before entering the fray. At that point, they attack the market with a simplified value-for-money product offering. Execution excellence—that is, efficient development and speedy production—is crucial for these players. Other companies in this category include Monolithic Power Systems, Richtek Technology, MStar Semiconductor, and RDA Microelectronics. With the ongoing commoditization of manufac- turing services and better access to leading-edge intellectual property, the fabless industry will profit from its focused business system. We expect these players to dominate more and more successful applications, especially in consumer electronics and some areas of IT. IDMs and even established microcontroller and micropro- cessor players will continue to cede ground to fabless competitors. The compound annual growth rate of the fabless segment, which currently outperforms the overall semiconductor industry by more than 5 percentage points a year, seems sustainable over the longer term. A more interesting model that may be reemerging is that of the integrated original-equipment manufacturer (OEM). In the past 30 years, many OEMs, such as Motorola and Hewlett-Packard, divested their semiconductor arms due to the high capital intensity of these businesses and the need for scale. Today, a new generation of OEMs that are tied neither to in-house process technologies nor to software development are taking more ownership of integrated-circuit design. Apple and Google may indicate the emer- gence of a larger trend, in which we see that the intellectual property for functional design may not belong fully to the chip maker but to a new kind of integrated OEM. With valuable functional designs in hand, such players may in-source or outsource chip design based on cost. Companies such as Apple and Google have sufficient scale and capability to become fabless for both the box and the chips. Because these OEMs tend to be market leaders, they can compete with innovator and fast-follower companies for share in the overall profit pool. Of course, OEMs without the scale or skills will continue to rely on mature- market attackers to sustain their businesses. Front-end manufacturing: What are the limits of vertical disintegration? Over the past several years, many semiconductor companies have decided to go “fab lite,” or step out
  38. 38. 36 McKinsey on Semiconductors Autumn 2011 of some aspects of the capital-intensive, leading- edge front-end technology-development and fabrication part of the value chain. Nearly all IDMs have outsourced some of their production to foundries. Even the Japanese, who are known for their reluctance to give up in-house capabilities, are going asset light, at least in part. Examples include Fujitsu, Renesas Electronics, and Toshiba. As a result, the foundry business has surged over the last decade, outperforming IDMs by an average of about 5 percentage points each year (Exhibit 2). In the longer term, the foundry business has evolved over the last 20 years. Although it earlier competed on factor cost advantages, produc- tivity gains, and operational excellence, it now depends on true technology leadership, scale advantages, and a superior ecosystem for product design. Modern foundries can provide every type of support: for example, developing intellectual property, offering photomasks, and offering access to networks of third-party design centers. Services even include competence in testing and packaging. More recently, foundries have started to offer 3D expertise, interposers, and back-end integration as a means of differentiating themselves from competitors. As noted above, in the early days, the foundry model generated profits primarily through low costs. Analysis of manufacturing costs that pitted European IDMs against Taiwanese foundries in the 1990s indicated that the cost advantages of the foundries were close to 50 percent. By the mid-2000s, leading foundries’ process technology reached parity with other leading-edge players in standard complementary- metal-oxide-semiconductor (CMOS) technologies. By the end of the 2000s, foundries became the core of new technology clusters. They no longer had to compete on price. Despite the fanfare, foundry volumes occupy only 20 percent of current manufacturing capacity Exhibit 2 Fabless and foundry businesses have grown above the industry average, whereas IDMs have grown below it. MoSC 2011 Moore’s Law Exhibit 2 of 5 1Integrated device manufacturer. Source: iSuppli; IC Insights; Gartner Revenue growth by value-chain slices, % compound annual growth rate, 2005–10 4 Overall 3 IDM1 9 Foundry 11 Fabless
  39. 39. 37The evolution of business models in a disrupted value chain (Exhibit 3). With the expertise that many foundries currently possess, when will this business model truly take off? The reality is that there probably will not be any great jump in market share. Growth in the foundry business has rested on three pillars: first, leading-edge fabless companies such as Qualcomm and Nvidia rely on foundries to produce their designs, including hot products such as application-specific integrated circuits (ASICs) and application-specific standard products (ASSPs), all of which are sold into the global semiconductor market. A second pillar of growth has come as a result of IDMs looking to go fab lite; examples include NXP, Texas Instruments, Freescale, Fujitsu, and Renesas. The third growth driver has been increasing share among existing customers due to foundries’ ability to produce chips for cutting-edge and trailing products at a lower cost. In our market model, we expect most new ASIC or ASSP capacity to be built within the foundry ecosystem. In addition, all the new leading-edge capacity for nonmemory applications will end up at foundries or Intel. Nevertheless, we assume it will be difficult for foundries to gain share at the lagging edge of the chip market because IDMs are producing them based on sunk-cost economic models. It will be equally challenging for them to move in on the specialty technology businesses of IDMs, which also thrive due to depreciated assets (and which display relatively low portability across fabs precisely because of the level of specialization in these products). Given these assumptions, the slowdown of Moore’s Law node migration and the fact that most IDMs have already turned asset light will impede foundry growth. In total, we expect the segment to grow 5 to 10 percent a year, rather than the 10 to 15 percent it grew in years past. Exhibit 3 Despite early fanfare, foundry volumes remain low relative to IDMs. MoSC 2011 Moore’s Law Exhibit 3 of 5 1Integrated device manufacturers. Source: iSuppli, Q4 2010; World Semiconductor Trade Statistics, Q4 2010; McKinsey analysis Semiconductor fab capacity for foundries and IDMs,1 %, total in million 8-inch-equivalent capacity per month Foundry capacity share IDM capacity share 100% = 2000 91 9 9.4 2002 88 12 8.9 2004 85 15 10.3 2006 85 15 12.6 2008 83 17 14.2 2010 80 20 14.6
  40. 40. 38 McKinsey on Semiconductors Autumn 2011 While foundry demand may be growing less quickly, a great deal of capacity is coming online. As a consequence, we expect leading foundry players such as TSMC, Samsung, Global Foundries, and United Microelectronics Corporation to compete for customers more aggressively than they have in the past, as capital expenditure and process-technology development costs skyrocket. Second-tier players from China and Malaysia will also try to operate at capacity. In addition, Japanese IDMs might give away surplus capacity to potential customers at “cash cost,” hurting the foundries’ price points. All in all, price compe- tition in this sector will likely intensify. Exhibit 4 Four leading OSAT players adjusted their business models and are generating economic profits. MoSC 2011 Moore’s Law Exhibit 4 of 5 1Calculated as (return on invested capital – weighted average cost of capital) × invested capital. 2Outsourced semiconductor assembly and test; the 4 players referenced in the chart are Amkor Technology (Amkor), STATS ChipPAC (Stats Chip), Siliconware Precision Industries Co. Ltd. (SPIL), and ASE Global (ASE). Source: McKinsey Corporate Performance Analysis Tool Economic-profit generation1 for the top 4 OSAT2 players, $ billion Value-destroying phase Value-generating phase 1,600 –1,600 1,400 –1,400 1,200 –1,200 1,000 –1,000 800 –800 600 –600 400 –400 200 –200 –175 –131 –393 783 755 167 11 0 2004 2008 20092007200620052003 Amkor –75 ASE –61 SPIL 0 Stats –39 Chip Amkor –125 ASE 38 SPIL 58 Stats –101 Chip Amkor –147 ASE –266 SPIL 122 Stats –103 Chip Amkor 138 ASE 368 SPIL 239 Stats 39 Chip Amkor 131 ASE 272 SPIL 348 Stats 4 Chip Amkor 70 ASE 21 SPIL 119 Stats –42 Chip Amkor 42 ASE –57 SPIL 145 Stats –119 Chip
  41. 41. 39The evolution of business models in a disrupted value chain More recently, the earthquake and tsunami in Japan brought the need for supply-chain diversification to the forefront. Specialization and geographic concentration, which helped drive success in foundries in the past, are now becoming risks. Will foundry companies be able to provide risk diversification from natural or man- made disasters? Will OEMs be willing to bear the infrastructure costs associated with having multiple suppliers on fragmented campuses manufacturing interchangeable and commoditized technologies? The answers to these questions are unclear at this time. However, continued business-model innovation is needed to enable multisourcing with minimal cost impact, if not further cost reduction. If this evolution can be achieved, it will likely drive continued disintegration in the semiconductor value chain. All in all, it does not look as if the foundries’ current 20 percent market share will grow appreciably anytime soon. Indeed, in addition to interfoundry competition, these players are quite likely to face competition from other players along the value chain such as Intel and Samsung. Given these facts, and the implications of deceleration with regard to Moore’s Law, how will foundries capture a fair, if not disproportionate, share of the profit pool? From the other side, how will customers capture more value from the foundries? Naturally, the big foundries would favor fewer foundry players. At the same time, OEMs, IDMs, and fabless players would prefer to have multiple leading-edge foundries. Investment for capacity, partnerships, alliances, and distribution of orders across foundries over the next three to five years will be crucial in determining the competitive dynamics of the industry. Back-end manufacturing: The race for miniaturization brings success to OSAT players Chip packaging has shifted to an outsourcing model more quickly and more extensively than front-end processes have. In fact, many expect that the outsourced share of this segment could reach 50 percent of the market by 2013. In the not-too-distant past, outsourced semicon- ductor assembly and test (OSAT) companies were regarded as low-end, commoditized service businesses, and the competitive dynamics of the business were driven by price competition. This had a negative impact on the economics of the industry. Between 1996 and 2006, the sector, cumulatively, delivered no significant economic profit. However, the same analysis for the next three years shows a very different result (Exhibit 4). Part of the OSAT industry has undergone a transformation, and there are now two profitable subsegments: the very profit- able high-end players and the less successful mainstream OSAT players. As the pace of innovation slows in the front-end segment of the semiconductor market, the pressure on back-end companies is increasing; these players are expected to offer sophisti- cation and technical differentiation in a bid to increase chip performance. Technological differentiation will continue to drive the two-tier market structure: there will be oligopolistic high-end players and commoditized mainstream players. The OSAT industry can stay profitable at the high end as long as the top players have the technical skills required to differentiate the degree to which the chips they receive from foundries can be tuned to the needs of different products—and if they are able to avoid price wars.
  42. 42. 40 McKinsey on Semiconductors Autumn 2011 Four leading OSAT players have redefined their businesses models successfully and are generating economic profits. Amkor Technology, STATS ChipPAC, Siliconware Precision Industries Co. Ltd., and ASE Global are the four high-end OSAT companies, and each has significantly improved its profitability since 2006, leaving aside some turmoil caused by the Lehman Brothers collapse and resulting economic downturn. These companies successfully migrated from value destruction to value creation by focusing on improved capital productivity through careful management of investments and by introducing more sophisticated pricing models. Further- more, they invested in advanced packaging tech- nologies and improved miniaturization technologies, such as ball grid array (BGA) and flip-chip BGA, and shifted their product portfolio to those categories. The top four OSAT companies account for 80 to 90 percent of all outsourced substrate-based packaging services (Exhibit 5). On the other hand, lead-frame packaging services have become essentially a commoditized market. Technology-based differentiation allows certain players to access more specialized markets. In those narrower niches, pricing pressures are much lower than they are in the more commoditized packaging segments. Companies thus want to be in the sub- strate rather than the lead-frame packaging- services game. These four companies avoided the vicious price competition of the early 2000s, and they also improved their cost position, reducing capital expenditure by planning capacity more carefully and by avoiding unnecessary capacity buildup. One way they have done this is by maintaining leadership in technology, Exhibit 5 Revenues can be broken down by package type. MoSC 2011 Moore’s Law Exhibit 5 of 5 1Outsourced semiconductor assembly and test; the 4 players referenced in the chart are Amkor Technology (Amkor), STATS ChipPAC (Stats Chip), Siliconware Precision Industries Co. Ltd. (SPIL), and ASE Global (ASE). 2Figures may not add up to 100% because of rounding. 3Includes bumping. 4Wire-bonded ball grid array. Source: Company filings; expert interviews; McKinsey analysis OSAT1 revenue split (among top 4) by package type,2 %, FY 2008 Top 4 players 36 27 23 5 22 17 23 18 5 3 9 3 13 6 7 9 14 10 13 8 10 20 79 65 54 Flip chip3 ASE SPIL Amkor OthersStats Chip WB BGA4 Lead frame Testing Overall $2.3 billion $4.5 billion $9 billion $4.6 billion $20 billion
  43. 43. 41The evolution of business models in a disrupted value chain which has allowed them to establish equipment- consignment agreements with key accounts, thus avoiding overproduction and reducing the need for capital investment. As the technology race shifts to OSAT players, the industry will find itself at a turning point. For the leading high-end OSAT players, the lifeline has been the industry’s increasing need to package smaller, advanced-node chips. Will those leading- edge players be able to break away and maintain a comfortable and profitable oligopoly? Or will mainstream players also enter the advanced- packaging technology race, creating price competition that will likely take value away from the current players in the OSAT sector? The deciding factor may be the advantage that accrues to companies that lock in the limited external resources that allow them to maintain differen- tiability or to play catch-up. Those limited resources might include capital investment from leading-edge foundries seeking to provide integrated solutions, or the advanced-packaging technologies held by players in high-cost countries, such as the Japanese IDMs. The deceleration in progress along Moore’s Law has changed the rules—from a strong and almost sole focus on process-technology development to a more diverse set of success factors, such as additional value-added services, operational performance and responsiveness, intellectual property, and cost management. This industry, which had represented the essence of advanced technology, is becoming more com- moditized, and competition within any given slice of the semiconductor value chain will continue to escalate in the years ahead. The competitive arsenal is expanding to include a number of manage- ment skills—such as strategies for mergers and acquisitions—that will help companies battle other players’ strengths, securing intellectual property and locking in market share. Operational excellence is yet another imperative. Those that can get the mix right and adjust their business models to the changing landscape will be well positioned to break the boom-and-bust cycle and generate strong economic profits in the years to come. Ulrich Naeher is a director in McKinsey’s Tokyo office, where Sakae Suzuki is a principal. Bill Wiseman is a principal in the Taipei office. Copyright © 2011 McKinsey Company. All rights reserved.